Trading in the forex markets can be a very lucrative activity provided you know what you are doing and understand the risks. Before you enter any trade, it is critical for you to learn exactly how the market is behaving at the moment, whether price movement is range-bound or trending and what is likely to happen in the coming times given the current circumstances.
This is far more critical when you are forex trading than when you are dabbling in the stock market because of the wide variations that can occur within a surprisingly short span of time when you are dealing with currencies.
When is a currency range-bound?
The forex trader describes the trading environment as being range-bound when the currency pair price movement stays within a restricted trading window. That means, the currency pair’s high and low price points are fairly predictable. The price stays within the same range, often touching either high or low point before returning to a level well within the established range. Even when prices are moving sideways or oscillating within a horizontal window, the currency is said to be trading in a range.
The challenge that most traders face when currencies are trading range bound is that there is no discernible pattern that the price follows. In effect, it is a near impossible task to determine when the price will move, in which direction and to what degree. In such circumstances, it becomes difficult to estimate when trades should be entered or exited for maximum benefit. Typically, traders look for trending environments because range bound currencies offer limited reward potential.
When is a currency trending in the market?
The currency is trending in the market place when it shows a strong movement in a single direction. The main characteristic of a trending currency pair is its decisive movement either upwards or downwards for anywhere between a couple of weeks to more than a year. Short term trends last a few weeks, typically less than a month. Long term ones may continue for over a year. Typically, short term trends offer great opportunities to forex traders who will look up the long term trends to determine when and whether to enter or exit the pair.
The challenge with trending currency pairs arises when contrary short term trends emerge within a long term trend. For instance, a pair that is trending bullishly for a year may have a few bear movements along the way, making decision-taking significantly complex for new comers to the forex market. In general, reading chart patterns should give you a clear indication of a strong trend, especially medium and long term ones.
Is your currency pair trading range-bound or trending?
Experts use certain parameters to determine if a currency pair is trading range-bound or is trending:
· Average Directional Index
The ADX is one of the most useful tools to determine whether a currency pair is trading range-bound or trending, and also to evaluate the strength of the trend. A range-bound currency pair shows a declining ADX level (20 and falling) while a trending pair shows a rising ADX (25 and growing to indicate that the trend is gaining strength).
· Bollinger Bands
A key indicator of volatility, Bollinger Bands are popular tools for forex traders. When the bands are grouped and they grow together, range bound trading is indicated. The bands are tight and close, and the currency has a narrow gap within which it’s price oscillates.
· Moving Average Convergence Divergence
The MACD is a popular momentum indicator which compares two Exponential Moving Averages and maps the difference in the form of a single line. Positive momentum is indicated when the MACD is above zero line and negative momentum is indicated when it is below this line. When the line is rising, the currency pair is trending and when it is declining the currency pair is trading range-bound.
The degree of volatility is also a good indicator of whether a currency pair is trending or range-bound. When volatility is high, the currency pair is trending and while volatility is low, prices are moving within a restricted band, i.e. they are range-bound.